Global Economics

Asia Takes Flight on Low-Cost Carriers

Thailand has been the epicenter of political melodrama recently with the military ouster of Prime Minister Thaksin Shinawatra (see BusinessWeek.com, 9/20/06, "Markets React to Thai Coup").

But a change of leadership hasn't changed the fact that big money is at stake when it comes to positioning the country as a transportation hub, thanks to the current boom in Asia travel. So coup or no coup, Thailand stuck to its planned opening on Sept. 28 of the country's $4.1 billion Suvarnabhumi Airport, located about 18 miles (30 km) outside Bangkok.

What's interesting about the state-of-the-art airport, other than its site on an old cobra swamp, is that it features a $180 million "Budget Terminal" reserved exclusively for low-cost carriers, set to open early next year. It joins other such terminals focused on short-haul flights around the region. Singapore and Kuala Lumpur opened their own earlier this year, while airport authorities in Manila have converted the former U.S. Clark Force Base into one as well.

QUICK GROWTH MARKET. This makes sense given that the fastest growing segment of Asia travel is to destinations within the region in India, China, and Southeast Asia. In recent years a whole class of low-cost carriers such as AirAsia and Tiger Airways in Southeast Asia and Indian players such as Air Deccan and SpiceJet have expanded routes and purchased planes to meet demand.

And they are starting to give traditional flagship international carriers a run for their money on some intra-regional flights. "People said the low-cost model won't work in Asia," says Tony Fernandes, CEO of AirAsia and a budget carrier industry pioneer. "Now they are talking about how fast we can grow."

These types of airlines were barely on the radar screen at the start of the decade. Yet based on their current growth trajectories, they are expected to represent about 12% of all available seats in the region by the end of the year, and that share could reach 20% by 2010, figures Derek Sadubin, an analyst at the Center for Asia Pacific Aviation in Sydney.

NO SIGNS OF SLOWING. In India, the short-haul carriers have grabbed about 29% of the market in three year's time and could account for an astounding 70% by the end of the decade. Regionwide, "there is no reason to believe this explosive growth won't continue for at least five years," Sadubin says, "and what's happening in India is nothing short of a revolution."

Indeed, what started off just five years ago as a primarily Malaysian phenomenon, with the launch of budget carrier AirAsia, has become a hot industry trend. Low-cost carriers have sprouted up in Thailand, Indonesia, Singapore, Philippines, and Macau as governments have discovered the wisdom of air transport deregulation.

In Malaysia, no-frills AirAsia now has over half of the domestic market. It's not likely all of them will survive, but the underlying trend driving this segment of air travel shows no signs of slowing.

The low-cost carriers, of course, differ vastly from full-service flag-carriers. Much like their brethren in Europe such as Ryanair (RYAAY) and EasyJet (EJETF), or Southwest Airlines (LUV) in the U.S., these Asian carriers provide bare-bones service and one class of seats.

They stick to a single type of short-haul aircraft to keep labor and maintenance costs to a minimum. They also take bookings via the Internet or phone to avoid paying commissions to travel agents.

NOT ENOUGH PLANES. Seat capacity on low-cost carriers worldwide has more than doubled in just four years, and they now operate about 14% of all global passenger flights. In Asia, budget carriers are expected to grow 65% this year compared with 8% growth for the overall regional travel industry.

"Low-cost travel in Asia was just a revolution waiting to happen," says AirAsia's Fernandes. "Carriers like ours have helped made air travel more affordable."

Asians, says Fernandes, are traveling more frequently in Asia than they were five years ago "because they can now use the money they save on airfares to stay in better hotels or do more shopping or in places like Macau, gamble a bit more." AirAsia, which has affiliates in Indonesia and Thailand, now flies 46 aircraft and has 89 more on order. "We are running over 80% capacity on almost all our routes and I wish I had 100 more planes," adds Fernandes. Analysts expect AirAsia to post profits of $53 million on sales of more than $330 million in current fiscal year ending June, 2007.

Fernandes says the region has just the right demographics for an explosion in low-cost air travel. Asia has high economic growth with fast-growing disposable incomes, but infrastructure, such as high-speed trains and highways, hasn't kept up, and car penetration is still low. Moreover, full-service airlines were virtually gouging passengers who couldn't afford to pay the high fares.

WHERE IT'S AT. Typical intra-regional fares in Asia until recently were two to three times fares in the U.S. and Europe for similar distances. On routes where low-cost airlines have had free rein, such as Singapore-Bangkok, Singapore-Macau, or Bangkok-Macau, fares are now almost comparable to similar routes in Europe and the U.S.

The Singapore-Bangkok route, one of the busiest, has seen nearly a 60% jump in traffic and a 75% percent increase in frequency since 2000. Average fares have fallen to a third of what they were five years ago.

Asia is the center of growth in global air travel. A third of the world's air traffic now originates there, and the region's air traffic growth is 8% to 9% a year, compared with 3% to 4% global growth.

Asia accounts for 40% of new aircraft orders for Boeing (BA) and Airbus. The key driver of Asian air traffic growth is not full-service carriers such as Singapore Airlines (SPAAF), Cathay Pacific, Thai International, or Korean Air, but small local and regional low-cost carriers.

To be sure, better-run traditional full-service carriers have managed to hold their own. Peter Hilton, Asian aviation analyst for Credit Suisse, says Asia's "large, full-service carriers such as Cathay Pacific and Singapore Airlines have very successfully defended their own turf by continuing to differentiate themselves."

PROTECTING LOCALS. Yet the upstart carriers are likely to expand their reach later in the decade. In Southeast Asia markets starting in January, 2008, all restrictions on the region's carriers flying into neighboring countries will be lifted under the new free skies policy first negotiated by ASEAN (Association of Southeast Asian Nations) a decade ago.

Currently, low-cost carriers can't fly between Singapore and Malaysian cities such as Kuala Lumpur and Penang. Two years ago, Indonesia banned foreign low-cost carriers (other than those that had already been given permission) from flying to key destinations including Jakarta and Bali to protect its own nascent no-frills carriers.

Last month, Malaysian and Singapore officials declared that they would soon throw the sector open to budget carriers. Tony Davis, CEO of Tiger Airways (49% owned by mega carrier Singapore Airlines), says his airline can fly to key Malaysian routes from Singapore "for less than the current bus fares."

The tumble in oil prices recently is likely to be a boon as well, according to Credit Suisse's Hilton. "Oil makes up a larger portion of LCC (low-cost carrier) total costs, and they serve a more price sensitive market, so lower fuel costs are likely to be a huge plus," he says.

JUST A BUBBLE? Nowhere has the growth been more spectacular than in India, where Air Deccan, SpiceJet, GoAir, and IndiGo have grown rapidly, taking a 29% share of the local market since deregulation began three years ago. Their share will reach nearly two-thirds by the end of the decade. The domestic market is likely to more than double over the next five years to around 60 million passengers by 2010, and analysts say low-cost carriers are expected to absorb most of this growth.

Some industry insiders say the Indian explosion in budget carriers is a business bubble about to burst and that a shakeout is looming. Indian regulators have in recent weeks expressed concerned that competition is so fierce that some of the weaker players might go bust.

But analysts say New Delhi should allow free markets to take their course. "The next two years will be crucial in India, the low-cost carriers that can get through the next 18 to 20 months are probably going to come out as strong long-term players," says Sadubin.

The budget travel bonanza has been far slower to take hold in Northeast Asia, where regulation is stiffer. In China, new aircraft purchases, as well as domestic fares, are regulated, while in Japan the availability of gates at airports such as Haneda, and heavy regulation, are huge issues.

Fare regulation in Taiwan and South Korea isn't likely to be lifted anytime soon, either. But in other parts of the region, expect the budget carrier revolution to continue to change the travel industry in profound ways.